Economic and Environmental Effects of Agricultural Insurance Programs
This paper observes that over the past decade crop insurance has evolved into the largest subsidy among U.S. farm programs. With the impending elimination of direct payments, crop and revenue insurance and the related "shallow loss programs" will be even more important, especially for program commodities. However, agricultural insurance programs stimulate production of the more subsidized crops and likely result in less diversification of crops, expanded planting on marginal land, and increased potential for adverse environmental effects of farming.
The Conservation Crossroads in Agriculture: Insight from Leading Economists Economic & Environmental Effects of Agricultural Insurance Programs by Daniel A. Sumner University of California, Davis and Carl Zulauf Ohio State University July 2012 Contents Executive Summary 1 Introduction 3 Recent Evolution of Crop Insurance in the United States 4 Crop Insurance Principles 5 Crop Insurance and the Evolution of Farm Commodity Programs 7 Crop Risks and the Role of Government 7 Effects of Crop Insurance Subsidies 8 Summary and Conclusions 13 References and Data Sources 15 Dan Sumner is Director of the University of California Agricultural Issues Center and the Frank Buck, Jr. Professor, Department of Agricultural and Resource Economics, UC Davis. Carl Zulauf is Professor, Department of Agricultural, Environmental, and Development Economics, Ohio State University. The authors thank Joe Glauber, Barry Goodwin, and Keith Coble for helpful guidance and Jessica Vergati for exemplary research assistance. More information is available at www.cfare.org ÂŠ2012 Published by C-FARE Executive Summary Crop insurance has evolved over the past decade to become the most important crop subsidy program in the U.S. For fiscal year 2013, crop insurance programs are budgeted to account for about 63 percent of all crop subsidies. With the proposed elimination of the direct payment programs in all main Farm Bill proposals, crop insurance will serve as the primary subsidy for domestic agriculture. This paper provides a review of the core economic rationale for subsidies for crop insurance and a review of the economic literature associated with crop insurance programs. In addition, the paper examines how certain design elements of the insurance programs may result in less diversification of crops, planting in marginal land and the potential to increase the use of inputs while reducing certain risk mitigation practices. Included in the findings is that crop insurance seems to affect production in three primary ways: 1 Evidence-based analysis supports that subsidized crop insurance encourages the movement of crop production onto marginal lands and can result in environmental risks that would not • The subsidies raise the net revenue per acre and thereby raise incentives to plant eligible crops and plant more of crops with higher subsidy rates; occur in the absence • The availability of crop insurance, which is made possible by the government program, encourages planting insured crops on fields that would not otherwise be considered for that crop because of the potential for significant losses; and insurance. • By reducing chances of losses from low yields and prices, crop insurance creates incentives for growers to undertake fewer other risk mitigating practices and therefore focus more on increases in average productivity. of subsidized crop In a review of crop insurance and environmental quality, although research is not yet definitive, the paper points out, evidence-based analysis supports that subsidized crop insurance encourages the movement of crop production onto marginal lands and can result in environmental risks that would not occur in the absence of subsidized crop insurance. For example, a large study conducted by the Economic Research Service (Lubowski, et al.) found that: “Increased crop insurance subsidies in the mid-1990s motivated farmers to expand cultivated cropland area in the contiguous 48 states by an estimated 2.5 million acres (0.8 percent) in 1997, with the bulk of this land coming from hay and pasture. This land-use change increased annual wind and water erosion by an estimated 1.4 and 0.9 percent, as of 1997.” Economic and Environmental Effects of Agricultural Insurance Programs 2 Regarding environmental consequences of subsidized crop insurance, the paper states that subsidies for crop insurance may affect environmental consequences through several channels including: • Incentives to expand onto more environmentally sensitive lands; • Incentives to use more inputs as average returns rise; • Incentives to shift across crops toward those, such as cotton, that may have more negative environmental consequences; • Incentives to use fewer risk-reducing practices and materials; and • Impact from the lack of environmental or conservation compliance rules for crop insurance as have applied to land under the traditional crop subsidy programs. Economic and Environmental Effects of Agricultural Insurance Programs 3 Introduction After a long history as a relatively small part of the U.S. farm program regime, price-based programs, and Congressional has served as both a stated rationale for efforts to broaden the availability and government-sponsored programs and a attractiveness of federal insurance. caution about whether demand by farmers for insurance against risks is as strong as crop insurance has evolved over the Economists have devoted substantial past decade into the most important attention to the underlying economic crop subsidy. For fiscal year 2013, crop rationale for government crop insurance Policy issues associated with government insurance programs are projected to programs. Basic insurance issues are insurance programs are (a) their public account for about 63 percent of all U.S. risk aversion, moral hazard and adverse cost, (b) the supply response of farmers Department of Agricultureâ€™s budgeted selection; as well as heterogeneity of to insurance subsidies and impacts on the outlays for farm subsidies (Figure 1). often portrayed. risk and correlation of negative shocks quantity produced and thus on commodity The dominant role of insurance reflects over time and across policyholders. For markets, (c) the geographic distribution the impact of recent high prices, which crop insurance, the lack of market-based of subsidies and resulting impacts on have eliminated payments from traditional insurance at commercially viable premiums spatial distribution of production, (d) the distribution of subsidies across farms and the impact on the size distribution of Figure 1 Budgeted USDA Outlays by Commodity Programa, Fiscal Year 2013 farms, (e) environmental impacts, and (f) the potential effects on obligations under international trade agreements, including potential challenges in the World Trade Organization (WTO). Other issues include the impact on organic agriculture and Crop Insurance 63% production for local consumption. Direct Payments 33% This brief review cannot delve into all of these complex insurance and policy issues in depth. It will also leave aside technical Other b 4% elements that have been the focus of much of the academic literature. After a brief description of current crop insurance a Tobacco buyout transactions, milk program outlays and conservation programs are not included. b Other includes Marketing Assistance Loans; Countercyclical Payments; Loan Deficiency Payments; Cotton Payments; Noninsured Crop Disaster Assistance Program; Biomass Crop Assistance Program; Farm Storage Facility Loans; Purchases and Sales; Processing, Storage and Transportation; Bio-based Fuel Production; Operating Expenses; Interest Expenses and other smaller outlays. Source: U.S. Department of Agriculture, Office of Budget and Program Analysis (2012). FY 2013 Budget Summary and Annual Performance Plan, U.S. Department of Agriculture. Accessed: http://www.obpa.usda.gov/. programs and some recent data about the evolution of the programs, we will consider briefly the core economics of the rationale for subsidies for crop insurance. Then we will consider what the economics literature suggests about the implications of current agricultural insurance programs. Economic and Environmental Effects of Agricultural Insurance Programs 4 Recent Evolution of Crop Insurance in the United States the FCIC. RMA oversees the delivery of and indemnities have increased about programs by private insurance companies, seven times to liabilities of $113 billion sets premium rates, pays for operation and and indemnities of $7 billion in 2011. management of the program including farm Premium subsidies have also risen to Congress authorized formation of the premium subsidies, and reinsures private about $7 billion in 2011 (Table 1). Federal Crop Insurance Corporation (FCIC) insurance companies against losses. in 1938. Crop insurance remained a small Since 2005, covered acreage has stayed program until the Federal Crop Insurance By any measure the federal crop insurance relatively constant as insured acres of Act of 1980 expanded both the crops and program has grown immensely since the the large-acreage crops of wheat, corn regions it covered. However, the modern early 1990s. The number of separately and soybeans have stabilized. However, crop insurance program can be dated to insured crops has increased from about liabilities have continued to grow. The the Crop Insurance Reform Act of 1994 50 to more than 300 depending on how reasons are higher crop prices, extending and the formation of the Risk Management crops are categorized. Insured acres have insurance to crops with a higher value per Agency (RMA) in 1995 to administer increased by 50 percent while liabilities acre, and farmer decisions to buy higher Table 1 Profile of the U.S. Crop Insurance Program, Selected Years, 1990-2011 a Year Total policies solda (million) Buy-up policies sold (million) Net acres insured (million) Total liability ($ billion) Total premium ($ billion) Total indemnity ($ billion) 1990 0.89 0.89 101.4 12.83 0.84 0.97 0.86 1995 2.03 0.86 220.5 23.73 1.54 1.57 1.02 2000 1.32 1.01 206.5 34.44 2.54 2.59 1.02 2005 1.19 1.05 245.9 44.26 3.95 2.37 0.60 2006 1.15 1.03 242.2 49.92 4.58 3.50 0.77 2007 1.14 1.02 271.6 67.34 6.56 3.55 0.54 2008 1.15 1.03 272.3 89.90 9.85 8.68 0.88 2009 1.17 1.08 264.8 79.57 8.95 5.23 0.58 2010 1.14 1.06 256.2 78.10 7.59 4.25 0.56 2011 1.15 1.07 265.3 114.07 11.95 10.71 0.90 Catastrophic (CAT) policies, introduced in 1995, make up the difference between buy-up and total policies. Source: U.S. Department of Agriculture, Risk Management Agency (2012). Summary of Business Reports and Data. Accessed: http://www.rma.usda.gov/data/sob.html. Economic and Environmental Effects of Agricultural Insurance Programs Loss ratio 5 coverage levels and revenue instead receipts has increased from 0.1 to 0.2 in difference between the loss amount and of yield insurance (see Figure 2). In the early 1990s to almost 0.6 in 2011 deductible. For example, if the deductible 1995, nearly all insured acres were at 65 (see Figure 3). loss is 10 percent and the actual loss percent or lower coverage, but by 2011 Crop Insurance Principles revenue insurance has grown dramatically in popularity, adoption of revenue insurance has lagged in specialty crops. The inclusion of California in Figure 2 illustrates this point. To summarize the growth in crop insurance, the ratio of insured liability relative to U.S. crop cash because it covers a range of events that before discussing current crop insurance may trigger low yields or low revenue, issues in the context of recent economic such as drought, frost, too much rain, etc. literature. As with all insurance, crop Multi-peril insurance is more costly than insurance makes an insurance indemnity insurance for a specific cause of a loss payment when a loss exceeds the because the potential for a covered loss insurance deductible. Payment equals the is higher. Under Revenue-Based Policies, U.S., 1995-2011 90 United States 70 60 50 40 20 California 10 2011 2010 2009 2007 2008 2005 2006 2003 2004 2002 2001 2000 1999 1997 1998 1995 0 1996 Crop insurance is multi-peril insurance A few concepts and principles are noted Figure 2 Share of Buy-Up Liabilities Revenue-based share of buy-up liabilities (%) payment equals 10 percent. Source: U.S. Department of Agriculture, Risk Management Agency (2012). Summary of Business Reports and Data. Accessed: http:// www.rma.usda.gov/data/sob.html. Figure 3 Ratio of Total Liabilities to Total U.S. Cash Receipts From Crops, 1990-2011 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 at 75 percent or higher coverage. While Ratio of liabilities to total crop cash receipts about 75 percent of insured acres were 80 is 20 percent, the insurance indemnity Sources: U.S. Department of Agriculture, Risk Management Agency (2012). Summary of Business Reports and Data. Accessed: http://www. rma.usda.gov/data/sob.html. U.S. Department of Agriculture, Economic Research Service (2012). Farm Income Data Files, Cash Receipts. Accessed: http://www.ers.usda. gov/Data/FarmIncome/finfidmu.htm. Economic and Environmental Effects of Agricultural Insurance Programs 6 Because adverse Two key issues associated with insurance selection, think premiums are too high are moral hazard and adverse selection. (Babcock, 2012 and Glauber, 2004). Moral hazard exists when insurance These farmers are less likely to purchase hazard increase alters decisions of the insured in a way crop insurance and this means that expected insurance that increases the probability of a loss. premiums are higher yet. selection and moral Moral hazard is considered especially claims, they must be problematic in a complex process such as built into premium crop production. Farmers make a series of rates and contribute to why some farmers, notably those with less moral hazard and adverse selection, think premiums are too high. managerial decisions from planting through harvest that influence yield and include considerations of risk. Many of these decisions can be influenced by whether or not the farmer has insurance. A standard tool used by insurance companies to manage moral hazard and adverse selection is a deductible. A deductible precludes payments on small losses, which are considered the losses most susceptible to either change in the management decisions because the farm has insurance (moral hazard) or are losses Adverse selection exists when a potential that the farmer knows more about than the insurance customer knows more than the insurance company (adverse selection). insurance company about the probability and magnitude of loss relative to the premium. For example, a farmer may know that his crop yields have a higher potential for large shortfalls and that the premium does not fully reflect his/her higher downside risk. Area-wide insurance is also used to address moral hazard and adverse selection. Halcrow (1949) pointed out that, when the cause of indemnities is outside the control of the individual farm, such as for insurance triggered by a countywide yield shortfall, the choice to buy insurance Neither moral hazard nor adverse selection is less influenced by adverse selection implies fraud or other illegal or immoral and the behavior after purchase is less behavior. They simply reflect the impact influenced by moral hazard. Mirandaâ€™s that insurance can have on decision- update (1991) of Halcrowâ€™s ideas making and differences in information stimulated research on setting premium known by the insured and the insurance rates and other operational issues for area company. insurance (see for example, Skees, Black Because adverse selection and moral hazard increase expected insurance claims, they must be built into premium rates and contribute to why some farmers, notably those with less moral hazard and adverse Economic and Environmental Effects of Agricultural Insurance Programs and Barnett, 1997; Miranda and Glauber, 1997; and Mahul, 1999.) However, areabased crop insurance has not had notable market success in the face of substantial competition from individual coverage at high-premium subsidies. According to 7 Since the New Deal, data from USDA, RMA, county insurance The geographical aggregation used to products accounted for only 2 percent measure shortfalls has received the same of the total net acres insured in crop economic analysis. As the breadth of farm commodity insurance during the 2011 crop year. geographical aggregation decreases, programs have say from states to counties, program provided benefits when Crop Insurance and the Evolution of Farm Commodity Programs cost increases because yields become prices or revenues more variable. were low. At the same programs have provided benefits when Crop Risks and the Role of Government prices or revenues were low. At the same Businesses face risk that has both little have provided time, various programs have provided correlation across firms (idiosyncratic payments when farms faced widespread risk) and risk that firms in the same line payments when farms losses on crop or livestock production. of business tend to share (systemic risk). faced widespread The Food, Conservation, and Energy Insurance is often easier and cheaper Act of 2008 (2008 Farm Bill) authorized for idiosyncratic risks, although adverse losses on crop or two revenue-based programs for the selection and moral hazard remain issues. program crops: the Supplemental Revenue Systemic risk, which may generate large Assistance (SURE) Program and the indemnities at the same time, creates Average Crop Revenue Election (ACRE) incentives for larger and more diversified program. ACRE enrollments were small insurance companies or reinsurance with and neither program is likely to survive in firms that cover potential losses across the 2012 Farm Bill. Programs similar to several different lines of risk. Since the New Deal, farm commodity ACRE, which offer government payments to producers of program crops when area-wide revenue fall relative to some recent benchmark, have been favored by commodity groups. Such programs would replace payments based on planting history and those based on a national price trigger (Zulauf and Orden (forthcoming.) One set of simulations find that such programs could have high government budget costs under some circumstances (Smith, Goodwin and Babcock, 2012). time, various programs livestock production. Systemic risk is important in most industries. For example, many industries face common variations in energy fuel prices, or recessions and fluctuations in exchange rates. Farming is also subject to considerable systemic risk. This risk arises in part from natural events such as frost, drought and excess moisture, both in the U.S. and internationally, and in part from variation in commodity prices and the prices of major production inputs. Economic and Environmental Effects of Agricultural Insurance Programs 8 Farm returns are less correlated with losses has not been available without 2007), and Sumner, Alston and Glauber the rest of business than are most other heavy government subsidy (Wright and (2010). For application to the current industries, as the farm revenue boom Hewitt, 1994; Tweeten and Zulauf, 1997). policy debate, Shields (2010) and Smith of the past five years has shown. That (2011) summarize useful facts and Effects of Crop Insurance Subsidies increases the opportunity for insurance companies to diversify across agriculture and other businesses. Of course, in most perspectives. Budgetary Cost of Crop Insurance The crop insurance literature began with industries, insurance for routine production Valgren in 1922, but this brief discussion and revenue variability is not common. draws on Goodwin and Smith (1995), Likewise, except for fire and hail insurance, Knight and Coble (1997), and the more insurance against farm yield and revenue recent expositions in Glauber (2004 and Government outlays for crop insurance have grown substantially over the past decade (see Table 2 and Figure 4). For the 2011 crop year, total government Table 2 Income and Expenses of U.S. Federal Crop Insurance Program, Crop Yearsa 2002-2011 Crop Year Farmer Paid Premium Premium Subsidyb Underwriting (Gain) / Loss Total Incomec Loss Claims Paid Claims in Excess of Total Income Administrative Expense Reimbursement Total Government Costsd $ Millions 2002 1,177 1,744 10 2,989 4,067 1,078 628 3,565 2003 1,393 2,061 -381 3,124 3,262 138 736 3,084 2004 1,720 2,481 -696 3,556 3,238 -318 894 3,200 2005 1,617 2,346 -915 3,097 2,370 -727 833 2,591 2006 1,906 2,687 -825 3,815 3,506 -309 962 3,465 2007 2,745 3,828 -1,574 5,045 3,551 -1,494 1,335 3,792 2008 4,171 5,696 -1,098 8,818 8,689 -129 2,013 7,717 2009 3,530 5,430 -2,277 6,750 5,234 -1,516 1,619 5,664 2010 2,891 4,714 -1,929 5,740 4,236 -1,504 1,371 4,724 2011 4,348 7,164 -1,007 10,585 13,103 2,518 1,383 11,209 Total 25,498 38,151 -10,692 53,519 51,256 -2,263 11,774 49,011 est. a Interest and other income, and other administrative and program costs are on a fiscal year basis. Remainder of the data is on a crop-year basis. May include additional subsidy from other sources. c Includes interest and other income. d Sum of premium subsidy, claims paid above income, administrative reimbursement, and other administration and program costs. b Source: U.S. Department of Agriculture, Risk Management Agency. â€œAbout RMA: Costs and Outlays.â€? Accessed on June 22, 2012 at http://www.rma.usda.gov/aboutrma/budget/costsoutlays.html. Economic and Environmental Effects of Agricultural Insurance Programs 9 Analysis has suggested cost for crop insurance is currently Most USDA reimbursement of insurance estimated to exceed $11 billion. Since company costs is calculated simply as a the 2002 crop year, premium subsides for percentage of premiums. But this makes it would be more cost farmers have accounted for approximately sense only if premiums reflect costs of effective, in terms of three-quarters while reimbursements to servicing a policy, and if premiums rise only crop insurance companies account for because of higher farm prices, insurance benefits for growers, about one-quarter of the governmentâ€™s company operational costs will not rise to simply provide crop cost. In recent years, farmers have paid proportionately (Glauber 2007). Babcock about 38 percent of the total premium. (2012) has suggested it would be more insurance for free, This share has raised a question about cost effective, in terms of benefits for whether the demand for crop insurance is growers, to simply provide crop insurance being driven by the premium subsidy rather for free, rather than subsidize the complex than by risk management (Glauber, 2004; system of administration and operation of administration and Goodwin, 2001). of insurance companies. Free insurance operation of insurance rather than subsidize the complex system companies. Figure 4 Total Federal Budget Costs of U.S. Crop Insurance Program, Crop Years 2002-2011 ($ in millions) 12,000 10,000 $ Millions 8,000 6,000 4,000 2,000 2011 est. 2010 2009 2008 2007 2006 2005 2004 2003 2002 0 Source: U.S. Department of Agriculture, Risk Management Agency. â€œAbout RMA: Costs and Outlays.â€? Accessed on June 22, 2012 at http://www.rma.usda.gov/ aboutrma/budget/costsoutlays.html. Economic and Environmental Effects of Agricultural Insurance Programs 10 would avoid adverse selection problems A relatively early paper by Nelson and operating loan defaults for lenders and and reduce operational costs. More than Loehman (1987) raised the issue that others who finance crop production. anything, the free insurance idea highlights subsidized crop insurance may encourage just how expensive the administration and increased production. Subsidies for crop operation of the crop insurance system has insurance may affect production in three become. ways: The budgetary cost of crop insurance First, by compensating growers for losses therefore focus more on increases in naturally depends on the level of and providing a subsidy in the process, average productivity. When the grower aggregation at which indemnities are paid subsidized public insurance will increase (or his banker) bears the full costs of and premium rates are set. For example, expected income per acre since farmers losses, he has an incentive to devote more Dismukes, et al. (2011) found that, are not paying the full actuarial cost of resources to reduce large potential losses compared with the state level, a county- the insurance. The higher expected (or even at the cost of lower average output. level revenue program would cost 28 to 32 average) net revenue should encourage For example, subsidized crop insurance percent more for wheat, cotton and grain farmers to plant insured crops and plant may encourage a grower to diversify less, sorghum and 16 to 19 percent more for more of the crops with higher subsidy and invest less in risk-reducing inputs such corn and soybeans.1 rates. In effect, it is reasonable to as prophylactic chemical treatments for hypothesize that subsidized insurance potential pest outbreaks. Year-to-year budget costs vary with crop prices and yields. In some years, such as 2009 and 2010, with very low loss ratios, premiums will have effects similar to that of a price subsidy. Third, by reducing chances of losses from low yields and prices, insurance creates incentives for growers to undertake fewer other risk-mitigating practices and Relatively few studies have addressed these topics, and their findings tend to be government costs are low. In years such as Second, the availability of crop insurance, specific to the region and crop examined. 2011 with indemnities, budget costs rise which is made possible by the government Wu (1999) found that Nebraska corn (Table 1 and Table 2). program, encourages planting insured farms that purchased insurance were more crops on fields that would not otherwise likely to also produce soybeans but less be considered for that crop because of likely to produce forage crops. Young, the potential for significant losses. More Vandeveer and Schnepf (2001) found generally, by removing the potential for small positive production effects of crop large losses from low prices or low yields, insurance. Goodwin, Vandeveer and Deal crop insurance, and especially revenue If subsidized insurance changes decisions (2004) found that a 30 percent decrease insurance, causes additional production about what mix of crops to grow, where in premium costs caused less than a 1 of covered crops, especially in risky areas. to plant them, and/or the process to percent increase in Midwest corn acreage Such effects may follow from risk aversion produce them, it can affect land use and and about a 1 percent increase in Northern on the part of growers or the costs of Plains barley acreage. The production Effects of Subsidized Crop Insurance on Production and the Environment environmental quality. 1 The differences among the crops are to be expected and reflect the variability of the agro-climate where the crops are grown and the degree to which production of a given crop is concentrated geographically. It is also worth noting that program cost varied little by level of aggregation for rice because its yield variability is low since almost all acres of rice are irrigated. Economic and Environmental Effects of Agricultural Insurance Programs 11 impacts measured by these studies are changed crop mix, finds increased likely to be small for three reasons. First, chemical use overall as a result of the acreage choices in the Midwest are limited crop mix change. by rotational considerations and by the lack of land available for expanding on the extensive margin. Second, impact of crop insurance on acreage choices in the Midwest and Plains states are further reduced because crop insurance is generally available for all relevant alternative crops. The impact may well be larger for other crops in regions with more diverse cropping alternatives. Third, the research preceded the recent expansion of the crop insurance program. No studies have directly analyzed the effects of crop insurance on yield. However, a few papers have considered the impact of crop insurance on input use (see review in Glauber 2004). Horowitz and Lichtenberg (1993) suggested that crop insurance may be a substitute for risk-reducing chemicals—a moral hazard response. Babcock and Hennessey (1996) and Smith and Goodwin (1996) report small positive effects of yield insurance on input use, during a period of time when subsidies were low and revenue insurance was uncommon—so these can be considered conservative compared with today’s higher subsidization rate. Babcock and Hennessy find that crop insurance is a substitute for farm chemical use so that on a per-acre basis, chemical use declines on insured cropland. However, Wu’s (1999) study that showed that crop insurance LaFrance, Shimshack and Wu (2002) Lands brought into or retained in cultivation due to simulated the effects of a variety of these crop insurance different insurance options. They conclude subsidy increases that “Land use is unchanged only when an actuarially sound and (unsubsidized) insurance contract is offered.” They go on to show that the increase in acreage are, on average, less productive, more devoted to crop production is on more vulnerable to erosion economically marginal land, especially and more likely to when the cost of insurance is subsidized. Lubowski, et al. (2006) used historical include wetlands and data on crop insurance program imperiled species participation and land uses to test habitats than cultivated the relationship between insurance subsidization and land use. They conclude cropland overall. that “Increased crop insurance subsidies in the mid-1990s motivated farmers to expand cultivated cropland area in the contiguous 48 states by an estimated 2.5 million acres (0.8 percent) in 1997, with the bulk of this land coming from hay and pasture. This land-use change increased annual wind and water erosion by an estimated 1.4 and 0.9 percent, as of 1997. Their empirical findings also substantiate LaFrance, Shimshack and Wu’s assessment that “… lands brought into or retained in cultivation due to these crop insurance subsidy increases are, on average, less productive, more vulnerable to erosion and more likely to include wetlands and imperiled species habitats than cultivated cropland overall.” Economic and Environmental Effects of Agricultural Insurance Programs 12 Although the results are not definitive, Net insurance payment is the difference Less information is available about the economics studies suggest that insurance between insurance payments made to distribution of benefits across farm size subsidies shift land into crops that have farmers of a crop and the insurance categories. Unlike the standard farm subsidized insurance and expand acreage premiums paid by the farmers. The ratio commodity subsidy programs, payment generally and, specifically, on marginal was calculated for each crop year from and revenue limits do not apply to crop lands that pose greater environmental 2001 through 2011 and averaged. These insurance subsidies. That means large threats. ratios differ substantially across crops. For operations are eligible for subsidized 2001 to 2011, the ratio was less than insurance on all their acreage. Some Distribution of Crop Insurance Subsidies 1.5 percent for rice, corn and soybeans; policy advocates express concern that between 3.3 percent and 4.3 percent for large farms get large benefits from Crop insurance benefits differ across farms peanuts, barley and oats; and greater than crop insurance subsidies. Nevertheless, by which crops are produced, how the 5.5 percent for wheat, cotton and sorghum no empirical evidence exists that crop crop is marketed and other characteristics. (see Figure 5). First note that all these insurance subsidies affect the farm size To consider the distribution across crops, ratios are well above 1.0. The range across distribution. (Figure 5) expresses net insurance crops underscores just how much crop payment per insured acre as a ratio to the insurance has benefited some major field national average of gross revenue per acre. crops relative to others. Advocates note that crop insurance subsidies are more available for standard crops grown in conventional ways in core production regions than for specialty and small acreage crops grown in outlying regions, for organic crops, and for crops Figure 5 Average Net Insurance Payment as a with emerging or rapidly changing markets. Share of Gross Receipts Per Acre by Crop for Major Field Crops, U.S., 2001-2011 Recent farm bills and other legislation have contained provisions that direct RMA to analyze the creation of crop insurance Sorghum 7.6% Cotton 7.0% Wheat 5.5% Oats 4.3% Barley 4.1% Peanuts 3.3% Soybeans Corn Rice 1.5% 1.2% 0.9% contracts for these types of commodities. The actuarial insurance concern and associated federal budget concern is that it is more difficult and costly to set appropriate premium rates for commodities for which there is less production history and for which there are few growers. Thus, costs of offering policies are likely to be higher and confidence is lower that premiums are correct. These considerations are highlighted by Singerman, Hart and Lence (2011) in their assessment of developing insurance products for Source: Calculated using data from U.S. Department of Agriculture, Risk Management Agency, Summary of Business Reports and Data, available at http://www.rma.usda.gov/data/sob.html. Economic and Environmental Effects of Agricultural Insurance Programs organic crops. 13 Economic reasoning Crop Insurance Subsidy and World Trade Organization Obligations and those that are likely to prevail after the especially prominent role. This prominence and empirical analyses The 1994 WTO Agreement on Agriculture makes crop insurance subsidies more strongly suggest (in Annex 2 paragraph 7) lists the vulnerable to potential challenge, especially characteristics of crop insurance programs as crop insurance subsidies have increased that crop insurance that would be “at most minimally trade in recent years. distorting.” The basic criteria require that 2012 Farm Bill, crop insurance will have an subsidies encourage production changes losses must be large (at least 30 percent) Summary and Conclusions before compensation is made. U.S. crop Economic reasoning and empirical insurance programs do not meet these negative environmental analyses strongly suggest that crop requirements. However, the cap on overall insurance subsidies encourage production effects of farming. WTO commitment for U.S. farm subsidies changes that increase aggregate negative The production is unlikely to be binding in the near future, environmental effects of farming. The so the failure of U.S. crop insurance to production changes themselves may changes themselves meet “green box” criteria is unlikely to be be relatively small for some crops but of significant concern under the 1994 because insurance encourages planting on agreement. marginal lands the environmental impacts subsidies are very small and percentage Of perhaps more concern is that WTO agreements specify that government subsidy programs (for agriculture or other products) may not significantly suppress prices or similarly distort market conditions from what would otherwise be available. If the set of U.S. farm subsidies for a commodity, including crop insurance, increases U.S. production and thereby reduces imports, increases exports or suppresses market prices, then other WTO members may have grounds to win that increase aggregate may be relatively small for some crops but are disproportionately high. The relatively because insurance few empirical studies on this relationship encourages planting generally date to an earlier time when crop insurance was a smaller program on marginal lands the with a lower degree of subsidization. Thus, environmental impacts they may understate the effects that the subsidization of programs has in 2012, with a larger, more diversified set of insurance programs at higher subsidy rates. are disproportionately high. More academic research of this issue at regional or national levels and with more current data is needed. a formal complaint. The market effects More research is also needed to measure of U.S. subsidies constituted one core the extent to which farmers respond to complaint in the WTO dispute over U.S. crop insurance subsidies by taking on more cotton subsidies that the United States risk elsewhere in their operation, such as lost in several rounds of legal decisions by shifting to cash rents or practicing less and appellate body rulings from 2003 diversification. through 2010. Under current conditions Economic and Environmental Effects of Agricultural Insurance Programs 14 Crop insurance subsidies are now thoroughly embedded within much of crop agriculture, especially the program crops, and farmers would confront adjustment costs if Congress reduced or eliminated The academic literature contains many Given rising budget costs, effects studies that examine insurance ratings on production and environmental issues, in particular the appropriate consequences, the threshold question yield distribution, and other program remains what convincing public policy operation issues, as well as the choice of rationale exists for the use of taxpayer insurance between individual and county funds to cover crop insurance premiums, insurance and the impact of premiums administration and operation costs for on the demand for insurance. However, delivery of insurance by private companies the academic literature remains limited or the reinsurance for potential losses by on issues such as the role of systemic insurance companies? Risk management risk, explanation of different payment is inherent in all sound business plans, rates across crops, and the potential whether in farming or other industries, consequences of payment limits. and most farms use forward contracts, futures markets, diversification and/ In the debate over the 2012 Farm Bill, or myriad other risk mitigation or risk commodity groups have favored replacing management practices and tools. Of payments tied to planting history and course, crop insurance subsidies are now market price with payments triggered by thoroughly embedded within much of crop area-wide revenue shortfalls for program agriculture, especially the program crops, crops. Researchers have yet to consider and farmers would confront adjustment many issues about such programs, but it insurance programs costs if Congress reduced or eliminated has been established that the cost of such the programs now. However, while the may provide a political programs is inversely related to the extent long history and recent growth of crop of geographical area used to determine reason for maintaining insurance programs may provide a political shortfalls. reason for maintaining the programs, they the programs now. However, while the long history and recent growth of crop the programs, they do not provide an economic rationale. Economic and Environmental Effects of Agricultural Insurance Programs do not provide an economic rationale. 15 References and Data Sources Babcock, B.A., and D.A. Hennessy. 1996. “Input Demand Under Yield and Revenue Insurance.” American Journal of Agricultural Economics 78(3):416–27. Dismukes, Robert, Keith H. Coble, David Ubilava, Joseph C. Cooper, and Christine Arriola. “Alternatives to a State-Based ACRE Program: Expected Payments Under a National, Crop District, or County Base.” U.S. Department of Agriculture, Economic Research Report No. (ERR-126) 42 pp, September 2001. Accessed June 28, 2012 at http://www.ers.usda.gov/publications/err-economic-research-report/err126.aspx. Glauber, Joseph W. “Crop Insurance Reconsidered.” 2004. Am. J. Agr. Econ. 86(5): 1179-1195. Glauber, Joseph W. 2007. “Double Indemnity: Crop Insurance and the Failure of U.S. Agricultural Disaster Relief Policy.” Agricultural Policy for the U.S. Farm Bill and Beyond. Bruce Gardner and Daniel A. Sumner Editors. American Enterprise Institute. Washington, D.C. (2007). Goodwin. Barry K. 2001. “Problems with Market Insurance in Agriculture.” Am. J. Agr. Econ. 83(3): 643-649. Goodwin, Barry K. and Vincent H. Smith. 1995. The Economics of Crop Insurance and Disaster Relief. American Enterprise Institute, Washington, D.C. Goodwin, B.K., M. L. Vandeveer, and J. Deal. 2004. “An Empirical Analysis of Acreage Effects of Participation in the Federal Crop Insurance Program.” American Journal of Agricultural Economics 86:1058–1077. Halcrow, Harold G. 1949. “Actuarial Structures for Crop Insurance.” Journal of Farm Economics 31: 418–43. Horowitz, John K. and Erik Lichtenberg. 1993. “Insurance, Moral Hazard, and Chemical Use in Agriculture.” Am. J. Agr. Econ. 75(4): 926-935. Knight Thomas O. and Keith H. Coble. 1997. “Survey of U.S. Multiple Peril Crop Insurance Literature Since 1980.” Review of Agricultural Economics. 19(1): 128-156. LaFrance, J.T., J.P. Shimshack, and S.Y. Wu. 2002. “Crop Insurance and the Extensive Margin.” World Congress of Environmental and Resource Economists, AERE/EAERE, 2002. Lubowski, Ruben N. Shawn Bucholtz , Roger Claassen, Michael Roberts, Joseph Cooper, Anna Gueorguieva and Robert Johansson. Environmental Effects of Agricultural Land-Use Change: The Role of Economics and Policy. USDA Economic Research Service. Economic Research Report No. (ERR-25) 82 pp, August 2006. http://www.ers.usda.gov/publications/err-economic-research-report/err25.aspx. Mahul, O. 1999. “Optimum Area Yield Crop Insurance.” American Journal of Agricultural Economics 81(1):75–2. Miranda, M.J. 1991. “Area–Yield Crop Insurance Reconsidered.” American Journal of Agricultural Economics 73:233–42. Miranda, M.J., and J.W. Glauber. 1997. “Systemic Risk, Reinsurance, and the Failure of Crop Insurance Markets.” American Journal of Agricultural Economics 79:206–15. Nelson, C.H., and E.T. Loehman. 1987. “Further Toward a Theory of Agricultural Insurance.” American Journal of Agricultural Economics 69:523–31. Shields, Dennis A. Congressional Research Service. 2010. “Federal Crop Insurance: Background and Issues.” Dec. 13, 2010. http://www. nationalaglawcenter.org/assets/crs/R40532.pdf. Singerman, Ariel, Chad E. 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Economic and Environmental Effects of Agricultural Insurance Programs 16 Smith, Vincent H., Barry Goodwin and Bruce Babcock. 2012. “Field of schemes: The taxpayer and economic welfare costs of shallow-loss farming programs.” American Enterprise Institute. http://www.aei.org/article/economics/fiscal-policy/field-of-schemes-the-taxpayer-and-economic-welfarecosts-of-shallow-loss-farming-programs. Sumner, Daniel A. Julian M. Alston and Joseph W. Glauber. 2010. “Evolution of the Economics of Agricultural Policy.” American Journal of Agricultural Economics 92(2): 403-423. Tweeten, Luther and Carl Zulauf. (Fall/Winter 1997). “Public Policy for Agriculture after Commodity Programs.” Review of Agricultural Economics. Volume 19, number 2, pages 263-280. U.S. Department of Agriculture, Economic Research Service 2012. Farm Income Data Files: Cash Receipts. Accessed: http://www.ers.usda.gov/Data/ FarmIncome/finfidmu.htm. U.S. Department of Agriculture, Office of Budget and Program Analysis 2012. 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Furtan. Kluwer Academic Publishers: Boston. Pages 73–112. Wu, J. “Crop Insurance, Acreage Decisions, and Nonpoint-Source Pollution.” 1999. American Journal of Agricultural Economics 81 (2) 305-20. Young, C. E., M.L. Vandeveer, and R.D. Schnepf. 2001. “Production and Price Impacts of U.S. Crop Insurance Programs.” American Journal of Agricultural Economics 83 (5) 1194-1201. Zulauf, C. and D. Orden. Forthcoming. “Managing Risk in Agriculture: An Assessment of Farm Safety net Proposals for the Next U.S. Farm Bill.” International Centre for Trade and Sustainable Development. Economic and Environmental Effects of Agricultural Insurance Programs III Acknowledgements Membership C-FARE aims to represent the interests of all professional agricultural economists in the United States. The Council consists of at least 15 members representing major groups within the profession. Three members are appointed by the Agricultural and Applied Economics Association, and by the National Association of Agricultural Economics Administrators. One member is appointed by the Southern Agricultural Economics Association. These seven directors elect at least six at-large representatives. C-FARE is a tax exempt organization under Section 501(c)(3) of the IRS code. Leadership 2012 C-FARE Officers Damona Doye Chair Oklahoma State University Roger Coupal Vice-Chair University of Wyoming Steven Kraft Secretary-Treasurer Southern Illinois University 2012 Board Members Soji Adelaja Michigan State University John Anderson American Farm Bureau Federation Walter Armbruster Farm Foundation Duncan Chembezi Alabama A&M University Gene Nelson Texas A&M Gail Cramer Louisiana State University J.B. Penn Deere and Co. Damona Doye Oklahoma State University Steve Turner Mississippi State University Jerry Fletcher West Virginia University Parke Wilde Tufts University Paul Gottlieb Rutgers University Bob Yonkers IDFA Steven Kraft Southern Illinois University Hector Zapata Louisiana State University David Lambert Kansas State University Lori Lynch University of Maryland Jon Brandt North Carolina State University Economic and Environmental Effects of Agricultural Insurance Programs www.cfare.org